Are you a landlord who hates having to pay the Capital Gains tax on every property you sell? Or are you someone who has heard about the 1031 Exchange but don’t know where to start? Well, you are in the right place! This article has everything there is to know about Capital Gains tax, 1031 Exchange, what types of Exchanges it applies to, and how to use it to your advantage. Paying taxes when you sell a property can quickly eat into your profits. If you plan to upgrade to a different property or similar investments, take advantage of Capital gains.
Let’s dive right into this. The first thing you need to be clear about is what Capital Gains Tax is. Capital Gains Tax is the tax you pay on the profit you receive from selling some property. It is assessed by deducting the sale price of the property from its original price. Thus, you pay the tax on how much profit you earn. The tax is only applicable once the asset has been sold. Capital Gains Tax is paid to the Internal Revenue Service (IRS), which is a government body responsible for tax collection.
The 1031 Exchange is a procedure that allows landlords and other property sellers to sell their property and buy a property like the one they just sold, all the while deferring Capital Gains Tax. Simply put, you are transferring your money from one property to another property, or you are exchanging properties. The rules that govern the 1031 Exchange procedure are set out in Section 1031 of the U.S Internal Revenue Code. Yes, that is where it gets its name from!
Read about the pros and cons of buying properties with cash vs mortgage.
1031 Exchange applies to people who are buying another property, not to the ones who are taking the cash out. You cannot simply sell your property and keep the profit from it, in the name of the 1031 Exchange, because under Section 1031, all proceeds from a sale of an asset are taxable. Think of it like this – you are exchanging your property for another one, and avoiding taxes throughout this, at least for the time being. Many investors use this procedure to trade properties without having an obligation to pay taxes all of a sudden. However, this is only applicable successfully when the value of the property you are exchanging (buying) with must be equal or more than the value of your old property (selling). This means if an investor is selling a property in California for $1 million, he or she will need to buy a property worth $1 million or more.
Cash flow or appreciation – pros and cons of both approaches?
Read our tips on investing in Class C properties to improve cash flow
The way it works is, to avoid taxes on the profit you just made, you need to invest that profit into another asset. This is where the role of qualified intermediaries comes in. Once you sell your property, the profits you earned from the sale must be transferred to a qualified intermediary. The qualified intermediary facilitates the 1031 exchange by holding on to the profit made by the sale of your property until you are ready to complete the transaction and purchase a new property. The money is then transferred to the seller of the second property, by the qualified intermediary. The qualified intermediary can have no relationship with the two parties involved in the buying and selling of the property. It must be a neutral party. It can be a person or a company, however we advise you to hire a professional to help facilitate the 1031 Exchange for you. This is simply because of the complex nature of the procedure.
8 Key skills to succeed in real estate investing
Using the 1031 Exchange procedure means you can avoid taxes until you sell your property and take the cash. If you simply exchange your properties for those of the same or higher values, you may never have to pay the Capital Gains tax!
There are four ways that real estate is exchanged. The 1031 Exchange procedure can be used on each of these.
What are property class A, B, and C and which one is right for you?
Using the 1031 Exchange procedure to save up precious money that would have gone to tax otherwise can be a very useful and intelligent thing to do when you are an investor or a landlord looking to sell your property. However, to go through with this successfully, you need to follow the specific rules that the 1031 Exchange is governed by. There are 7 rules in total, and they are explained below.
Real estate or stocks – which one is better?
Consider these 3 things before investing in real estate
If you have wondered what a 1031 Exchange is and how it works, this article has all you need to know about it. Once you understand how it works, you will realize it is not that difficult. The 1031 Exchange is a great way to save thousands, even millions of dollars that would have been paid to the IRS in the form of Capital Gains Tax. Check out HomeKasa for more articles on real estate and how the market works!
HomeKasa offers the best property management software to manage your investment properties. You can collect rent, schedule repairs, manage profit and loss, and more from one place. It’s free, get started now.